Mixed 3Q for Forest Oil

Zacks

Denver-based Forest Oil Corporation’s (FST) third quarter 2012 earnings of 10 cents per share (excluding non-recurring items) decreased significantly (by 60%) from the year-earlier earnings of 25 cents. The lackluster performance was mainly due to the higher depletion expense. However, the quarterly figure came slightly ahead of the Zacks Consensus Estimate of 9 cents.

Total revenue in the reported quarter decreased 10.4% to $156.1 million from the year-ago level of $174.1 million, and failed to meet the Zacks Consensus Estimate of $162.0 million.

Production

Net sales volumes increased 4.9% year over year to 339.1 million cubic feet equivalent per day (MMcfe/d) in the reported quarter, mainly attributable to the company’s extensive liquid-rich program.

Notably, the company has been able to raise its oil net sales volume, which organically increased 29% from the year-ago period and 7% sequentially to 8.9 thousand barrels per day (MBbls/d). However, natural gas sales volume shrunk 5.0% year over year to 224.9 MMcf/d, and comprised 66% of the total quarterly volume.

Realized Prices

The average equivalent price per Mcf (including the effect of hedging) was $5.84, down almost 4.9% from the year-ago realization of $6.14. Natural gas was sold at $3.57 per Mcf, down 23.7% from the comparable prior-year quarter, and natural gas liquids (NGLs) were sold at $31.07 per barrel, down nearly 9% from the year-ago quarter. However, average realized oil price was $96.90 per barrel, up 7.9% from the year-ago quarter.

Expenses

During the quarter, production expenses increased 10.3% year over year to $1.23 per Mcfe. Unit general and administrative expenses decreased 13.5% year over year to 32 cents per Mcfe from the year-ago level of 37 cents per Mcfe. Importantly, depreciation and depletion expenses per unit increased 30% to $2.37 per Mcfe from $1.83 per Mcfe in the third quarter of 2011.

Financials

At quarter end, Forest had $39.2 million of cash and cash equivalents with $2,092.4 million of long-term debt (including current portion), representing a debt-to-capitalization ratio of 89.6% (up from 73.6% at the end of second quarter 2012).

Company Outlook

The company is well on track to trim down its non-core properties during the second half of the year. This is needed to boost its financial strength and flexibility.

Recently, the company presented its revised guidance for net sales volumes and capital expenditures for the second half of 2012.

From July to December 2012, Forest Oil projects average net sales volumes to be in the range of 330 – 340 MMcfe/d. As per the updated guidance, 66% would comprise of natural gas and the remaining 34% will be oil and natural gas liquids production. The updated guidance is 3% higher than the prior outlook of 320 – 330 MMcfe/d.

Again, the company aims to put in approximately $240 million to $260 million on capital program, which is $50 million more than previously stated. The increased forecast highlights its expectation for better drilling efficiencies and activities. At present, Forest Oil is working with five rigs within its core Texas Panhandle, Eagle Ford and East Texas acreages.

The company remains well on target with its deleveraging plan, which commenced in early July, comprising transactions worth $277 million. It includes an agreement announced by the company in August with a subsidiary of Tristate Midstream II, LLC to divest a sizeable portion of its East Texas natural gas gathering assets. The deal is likely to fetch the company around $34 million. Recently, it also planned to divest all of its South Louisiana assets for $220 million.

Again, a recent $500 million senior notes offering will likely increase its financial flexibility.

Outlook

We like Forest Oil’s initiatives to increase liquids production, like its peer Chesapeake Energy Corporation (CHK). The company has entered the fourth quarter with five drilling rigs, which are all operating in liquids-rich prospects in its three core development areas that include its core Panhandle and Eagle Ford.

The company registered impressive results from its Hogshooter and Cleveland oil plays in the Panhandle Area and from its Eagle Ford program. Forest Oil intends to spend the remaining capital budget for the year mainly on higher-margin oil ventures.

However, we remain skeptical about its natural gas weighted production level. As natural gas accounted for 66% of the company’s total production in the third quarter of 2012, Forest Oil is exposed to the cautious outlook of the North American natural gas market. Its operations and cash flow are more sensitive to fluctuations in the market price for natural gas than to fluctuations in the market price for oil and NGLs.

We maintain our long-term Neutral recommendation on Forest Oil. The company holds a Zacks #3 Rank (short-term Hold rating).

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